John Paulson’s lost advantage

The billionaire manager’s flagship Paulson Advantage funds are quickly losing altitude after peaking with $19.1 billion in assets under management in March. As of the other day, the combined AUM of the Paulson Advantage and Advantage Plus funds had fallen to $15.7 billion, according to investor sources.

The Advantage funds account for roughly 44 percent of the $35. 2 billon in assets under management at Paulson. The two so-called event driven funds long have been the manager’s largest.

And the July performance numbers for the Advantage funds should be ugly. A source tells us the Advantage Plus fund, which is a leveraged version of the plain vanilla flagship fund, was down 4.63 percent in July. With that decline, the Advantage Plus fund is down a little over 21.6 percent for the year. The plain vanilla Advantage fund is believed to be down around 15 percent for the year.

The rapid shrinkage of the Advantage funds is largely the result of a series of bad bets and missteps by a trader who has taken on almost God-like status in the $2 trillion hedge fund industry. A good chunk of the $3.4 billion decline in AUM is due to the $482 million loss the Advantage funds incurred when Paulson unloaded shares of Sino- Forest–a Chinese forestry company accused of overstating its timber production and results. His big bets on financial stocks like Bank of America, Citigroup and CIT Group also are causing havoc for his portfolio.

Right now investors are putting in redemption notices to pull money out of the Advantage funds at the end of September. It’s not clear yet how much money investors will seek to redeem, but that no doubt could further impact the size of the flagship funds.

In an attempt to calm investor unease, Paulson conceded during a recent conference call that he had made some mistakes and was moving to reduce the overall long exposure of the Advantage funds. But Paulson, even in the face of weakening economic data, remains generally bullish on the prospects for a recovery and that could spell more trouble for his investors.

Paulson still doesn’t see a double-dip recession–even thought the rest of Wall Street seems to think otherwise. In midday trading Thursday, the Dow Jones Industrials were off 240 points and the S&P 500 is now down 2.16 percent for the year. Up until a few weeks ago, the S&P had been firmly in the green.

With the S&P in the red and heading lower, that can’t be good news for Paulson investors who have banking on a second-half turnaround for the star manager. Even after repositioning his portfolio, much of Paulson’s trades are premised on a coming recovery in the housing market and financials.

Then again, it took a while for Paulson’s famous bet on the collapse of the housing market to pay off and make him a billionaire many times over. But back then, the 55-year-old Paulson wasn’t nearly as famous he is now and few were watching his every move. And he didn’t have as many investors who were placing a bet on his ability to outsmart everyone else.